Chapter Three

External Analysis: The Identification of Opportunities and Threats

External Analysis
The purpose of external analysis is to identify the strategic opportunities and threats in the organizations operating environment that will affect how it pursues its mission.
Competitive structure of industry Competitive position of the company Competitiveness and position of major rivals

External Analysis requires an assessment of:

Industry environment in which company operates

The country or national environments in which company competes The wider socioeconomic or macroenvironment that may affect the company and its industry
Social Government Legal International Technological
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Analyzing the dynamics of the industry in which an organization competes to help identify:

External Analysis: Opportunities and Threats Threats

Opportunities
Conditions in the environment that a company can take advantage of to become more profitable

Conditions in the environment that endanger the integrity and profitability of the companys business

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Industry

Industry Analysis: Defining an Industry

Sector

A group of companies offering products or services that are close substitutes for each other and that satisfy the same basic customer needs Industry boundaries may change as customer needs evolve and technology changes A group of closely related industries Distinct groups of customers within an industry Can be differentiated from each other with distinct attributes and specific demands

Market Segments

before considering market segment or sector-level issues

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Industry analysis begins by focusing on the overall industry

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The Computer Sector: Industries and Market Segments

Figure 2.1

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Porters Five Forces Model

Figure 2.2

Source: Adapted and reprinted by permission of Harvard Business Review. From How Competitive Forces Shape Strategy, by Michael E. Porter, Harvard Business Review, March/April 1979 by the President and Fellows of Harvard College. All rights reserved.

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 Risk of Entry by Potential

Potential Competitors are companies that are not

Competitors

currently competing in an industry but have the capability to do so if they choose. Barriers to new entrants include:
1. Economies of Scale as firms expand output unit costs fall via:
Cost reductions through mass production Discounts on bulk purchases of raw material and standard parts Cost advantages of spreading fixed and marketing costs over large volume Achieved by creating well-established customer preferences Difficult for new entrants to take market share from established brands Accumulated experience in production and key business processes Control of particular inputs required for production Lower financial risks access to cheaper funds

2. Brand Loyalty

3. Absolute Cost Advantages relative to new entrants

4. Customer Switching Costs for Buyers where significant 5. Government Regulation

May be a barrier to enter certain industries
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Rivalry Among Established

Competitive Rivalry refers to the competitive struggle
1. Industry Competitive Structure 2. Demand Conditions 3. Cost Conditions

Companies

between companies in the same industry to gain market share from each other. Intensity of rivalry is a function of:
Number and size distribution of companies Consolidated versus fragmented industries Growing demand tends to moderate competition and reduce rivalry Declining demand encourages rivalry for market share and revenue High fixed costs profitability leveraged by sales volume Slow demand and growth can result in intense rivalry and lower profits Write-off of investment in assets Economic dependence on industry Maintain assets - to participate effectively in an industry

4. Height of Exit Barriers prevents companies from leaving industry

High fixed costs of exit Emotional attachment to industry Bankruptcy regulations allowing unprofitable assets to remain
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 Bargaining Power of Buyers

Industry Buyers may be the consumers or end-users who
1. Buyers are dominant.

ultimately use the product or intermediaries that distribute or retail the products. These buyers are most powerful when:
Buyers are large and few in number. The industry supplying the product is composed of many small companies. Buyers have purchasing power as leverage for price reductions. Buyers purchase a large percentage of a companys total orders. Buyers can play off the supplying companies against each other.

2. Buyers purchase in large quantities.

3. The industry is dependant on the buyers. 4. Switching costs for buyers are low.

5. Buyers can purchase from several supplying companies at once. 6. Buyers can threaten to enter the industry themselves.
Buyers produce themselves and supply their own product. Buyers can use threat of entry as a tactic to drive prices down.

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Bargaining Power of Suppliers

Suppliers are organizations that provide inputs such as
material and labor into the industry. These suppliers are most powerful when:
1. The product supplied is vital to the industry and has few substitutes. 2. The industry is not an important customer to suppliers.
Suppliers are not significantly affected by the industry.

3. Switching costs for companies in the industry are significant.

Companies in the industry cannot play suppliers against each other.

4. Suppliers can threaten to enter their customers industry.

Suppliers can use their inputs to produce and compete with companies already in the industry.

5. Companies in the industry cannot threaten to enter suppliers industry.

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 Substitute Products
Substitute Products are the products from
1. The existence of close substitutes is a strong competitive threat.
Substitutes limit the price that companies can charge for their product.

different businesses or industries that can satisfy similar customer needs.

2. Substitutes are a weak competitive force if an industrys products have few

close substitutes.
Other things being equal, companies in the industry have the opportunity to raise prices and earn additional profits.
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Strategic Groups are groups of companies that

Strategic Groups Within Industries

follow a business model similar to other companies within their strategic group but are different from that of other companies in other strategic groups. The basic differences between business models in different strategic groups can be captured by a relatively small number of strategic factors. Implications of Strategic Groups

1. The closest competitors are within the same Strategic Group and may be viewed by customers as substitutes for each other. 2. Each Strategic Group can have different competitive forces and may face a different set of opportunities and threats. Mobility Barriers factors within an industry that inhibit the movement of companies between strategic groups Include barriers to enter another group or exit existing group
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Strategic Groups in the Pharmaceutical Industry

Figure 2.3

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Industry Life Cycle Analysis

Industry Life Cycle Model analyzes the affects of 1. 2. 3. 4. 5. Embryonic industry just beginning to develop
industry evolution on competitive forces over time and is characterized by five distinct life cycle stages:

Rivalry based on perfecting products, educating customers, and opening up distribution channels. Low rivalry as focus is on keeping up with high industry growth.

Growth first-time demand takes-off with new customers Shakeout demand approaches saturation, replacements Mature market totally saturated with low to no growth Decline industry growth becomes negative
Rivalry intensifies with emergence of excess productive capacity. Industry consolidation based on market share, driving down price. Rivalry further intensifies based on rate of decline and exit barriers.
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Stages in the Industry Life Cycle

Strength and nature of five forces change as industry evolves

Figure 2.4

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Growth in Demand and Capacity

Anticipate how forces will change and formulate appropriate strategy

Figure 2.5

Industry Shakeout: Rivalry Intensifies with growth in excess capacity

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Life Cycle Issues

Limitations of Models for Industry Analysis

Innovation and Change

Industry cycles do not always follow the life cycle generalization. In rapid growth situations embryonic stage is sometimes skipped. Industry growth revitalized through innovation or social change. The time span of the stages can vary from industry to industry.

Company Differences

Punctuated Equilibrium occurs when an industrys long term stable structure is punctuated with periods of rapid change by innovation. Hypercompetitive industries are characterized by permanent and ongoing innovation and competitive change. There can be significant variances in the profit rates of individual companies within an industry. In addition to industry attractiveness, company resources and capabilities are also important determinants of its profitability.

Models provide useful ways of thinking about competition within an industry but be aware of their limitations.
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Punctuated Equilibrium and Competitive Structure

Figure 2.6

Industry Structure revolutionized by innovation Periods of long term stability Periods of long term stability

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The Role of the Macroenvironment

Figure 2.7

Changes in the forces in the macroenvironment can directly impact: The Five Forces Relative Strengths Industry Attractiveness

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